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fiscal policy

The federal government’s balance sheet is not like that of a private citizen’s, it shouldn’t always be balanced. There are certain times when running a deficit may be the best course of action. As a matter of fact, running a deficit is often a part of fiscal policy.

Federal deficits can help the government deal with the business cycle. The business cycle consists of four phases — growth, peak, recession, and trough/depression. In order to ease the economic tensions that occur during the business cycle, governments use deficits as a part of fiscal policy. The government runs the deficit by increasing expenditures either through buying goods, providing the public with subsidies, decreasing taxes, or some sort of combination of the three. The government’s increase in expenditures causes an increase in demand. This increase in demand leads to businesses experiencing increased profits. As a result, businesses do not lay off as many people during the recessionary phase.

On the other hand, if the federal government tried to always have a balanced budget, the business cycle would create larger fluctuations in the economy. For example, during the recessionary phase a larger numbers of workers would be laid off. However, federal deficits do have consequences. If the debt to GDP ratio is large enough then this could lead to problems like the ones seen in Greece. Additionally, there is actually not much reason to run a deficit when the economy is not in or near the recessionary phase.

So what about the US’ current debt situation. Although the US government does have debt, even when the US is not in the recessionary phase, the US has been able to handle its debt due to the strength of the US economy. The high revenue to debt ratio also allows more developed states, such as the US, to maintain higher levels of debt. Additionally, the US has been borrowing money at record lows, as a result the debt to GDP ratio should decrease over time. This means that the US may be able to wait longer to address its debt problems.

But how do we know when a state has too much debt? Investor confidence is one measure. Investor confidence often has a strong impact on the economy of states and can be a good way to determine how much debt is too much debt. For example, since interest rates, which have a relationship with investor confidence, on US treasury bonds are relatively low it would be reasonable to say that the US’ stability and developed economy outweigh the US’ high debt levels. However, this does not mean that the US can just racket up debt. The US debt will have to be addressed. If it continues to rise without being addressed then eventually the debt will get too large and lead to problems for the US economy, such as decreased employment and decreased levels of investment.